Investing Surplus Funds PDF

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INVESTING SURPLUS FUNDS Definition : Liquid balances held by a business, not required to finance current operations, not required for permanent short term investments. TYPES OF SURPLUS 1. LONG TERM SURPLUS(PERMANENT CASH SURPLUS - rare , no any foreseeable use . * Use to repay liabilities * No any foreseeable use * Pay dividends 2. SHORT TERM SURPLUS – There will be need for these funds in a short time , invested temporarily – treasury bills.

REASONS FOR HAVING SURPLUS 1. Unexpected large amount of cash from operations. 2. Low cost due to improved efficiency. 3. Improvement in working capital management. ( inventories, receivables, payables). 4. Sale of non-current assets. 5. Seasonal factors. (Eid, Christmas, Easter- Clothes business, Hotels in December).

INVESTING THE SURPLUS *Consider - Return - Look for the most profitable investment.

- Risk - is the degree of the variability of the returns. - Liquidity - Ability to convert the investment into cash when required. - Maturity - Period or Length of the investment. RISK 1. Systematic Risk: It affects a large number of assets. Therefore it is not possible to protect against it. Example: Political Risks. 2. Unsystematic / Specific Risk: Affects a small number of assets. Example: Credit Risks : Some don’t pay. Interest rate Risk.

* Always the issue of risk and return should be balanced off when investing surplus cash. Usually lower risk investments have a lower return, Higher risk the return shall be higher. - Low risk investment: Fixed deposit in a reputable bank. - Higher risk investment: Money market investment , Government securities. LIQUIDITY AND MATURITY - Liquidity is the ease and speed to which an investment is converted into cash. - Maturity is the length of the investment.

* If an entity is sure on when funds will be required , then the investment period will be aligned to that period considering the best return available. However, the exact duration of the surplus period is not always known and the future expected trends in interest rates can affect maturity of investments. MANAGEMENT OF SHORT TERM INVESTMENTS. Short term investments are intended to earn return over a short period of time , until when the business needs cash. *Pursue a good return. *Avoid excessive exposure to risks. * Ensure that liquidity is maintained.

MANAGEMENT OF LONG TERM INVESTMENTS. *Pursue a good return. *Avoid excessive exposure to risks. TYPES OF INVESTMENTS 1. DEPOSITS - Money market deposits. ($10,000) - Bank deposits : Similar to personal deposit account , with 7 day’s notice of withdrawal. - Local Authority deposit: Negotiable, several maturities available. - Sterling certificate deposits : certificate issued by the bank when funds are deposited and can be sold to a third party.

2. LOAN STOCK AND EQUITIES - Loan stock : Issued by the government and companies. * Government issuing - Treasury bond * Company issuing - Corporate bond - Equities : Highest risk. Retail Bank and Building society Accounts * Instant excess accounts: allow instant access to your cash. * Notice accounts: These accounts earn interest but there is a period in which that amount is lock. Period of notice is required before withdrawal.

* High interest accounts: Available for larger balances. ( minimum $500 to have this account) . Instant access to cash but also gives you interest. * Money market deposit: Available for larger balances of money. (Overnight up to 5 Years). * Option deposits: There are arrangements for pre-determined periods of investments ranging from 2 to 7 years. MARKETABLE SECURITIES - They can be traded with investors. ( can sell to each other)

1. Money market security : They are short term debt security/ instrument sold by government, companies or financial institutions. Example: Certificate of Deposit , Bills of Exchange , Treasury Bills, etc. 2. Capital market security: Have a long maturity. Usually more than one year. 3. Indirect investments: This is undertaken by purchasing shares of an investment company CERTICIATE OF DEPOSITS - It is a financial instrument issued by a bank certifying that the holder has the right to a fixed term deposit of funds earning a specified interest rate.

- You can sell it to any other investment before maturity date. - The certificate of deposit offer an attractive rate of interest at low credit risk. GILT - EDGED SECURITIES - These are marketable British government security. Face Value. $100 - Issued by the government to finance its spending and also control the money supply. $ 96.50 - They are categorized into: *Short-dated : Up to 5 years maturity. *Medium-dated : 5-15 years. *Long-dated : Over 15 years.

*Perpetuals: Don’t have maturity, never redeemed , there shall be there forever. * Gilt yields are measured using the following methods. 1. Coupon Yield : Coupon * 100% Nominal value 2. Interest Yield: Annual interest receivable *100% Market Price 3. Redemption Yield: Interest Yield +/(the difference between the market price and its eventual redemption value).

LOCAL AUTHORITY STOCK

- issued by the local government authorities with the ultimate backing of the government. - They have slightly higher yields than the government because they are less liquid. BILLS OF EXCHANGE - It is an unconditional order in writing from one entity to another requiring the entity to whom its written to pay a specified sum of money.(either immediately - sight bill or at a specified future date - term bill). * YOU OWE ME : demand for payment. Send bills demands payment

Drawes(supplier) Drawee ( customer) Makes payment on specified date * Trade bill: relies on the expectation that the drawee is credit worthy therefore it has a higher credit risk. *Bank bill : similar to trade bill, the drawee is a bank not a credit business. * The drawer of the bill will get more money from selling a bank bill then a similar trade bill. * Treasury bills : Short term debt instruments issued and sold by the central government

DISCOUNT MARKET - This is where a business with short term cash surplus can arrange through its bank to invest in discount market through purchasing either treasury bills or bills of exchange. - The investor shall be exposed to the following risks: 1. Credit Risk : Invest then someone doesn’t pay , get a loss. 2. Risk of changes in interest rate: You must strike a balance , low risk return low , high risk high return. CAPITAL MARKET INSTRUMENT

- These are those markets for raising long term capital. 1. Share capital : Several types a. Ordinary shares( Equity) : Represents a portion of the owner’s capital in a business. Holders of those shares have a voting right in general meetings. b. Preferred share capital : They have a fixed rate of dividend payout. Categories: 1. Participating preferred shares : Entitled to participate in the profit beyond the fixed dividends. 2. Cumulative preferred shares : Have a right to arrears of dividends. The dividend accrue if not paid because no profit.

3. Non-cumulative preferred shares : The dividends do not accrue if not paid maybe no profit. 4. Redeemable preferred shares: At maturity, the shares are repaid ( company pays them). 5. Convertible preferred shares: They can be converted in to ordinary shares at a future date. 2. Fixed Income Securities - The holders have no rights in the company beyond payment of fixed interest. After getting paid no further rights. - Several types :

1. Loan notes / debentures : it is similar to a mortgage which is a loan term loan , it is secured by a fixed or floating asset. 2. Loan stocks : It is a security issued by a company in respect of a loan made. It may be secured , unsecured(no asset) , convertible( convert into shares maybe after 6 months or an year) or nonconvertible. 3. Permanent Interest Bearing Shares in a Building Society(PIBS) : Special type of security created to enable building societies to raise funds....